You often hear people refer to themselves as ‘Sole Trader’ or ‘self-employed’ almost interchangeably – but do you really know the difference? Whereas ‘self-employed’ just means you work for yourself, a Sole Trader is a business structure within which you operate. Any ideas on what it is and how it works?
Sole Trader refers to someone who operates a business through themselves rather than via a separate legal entity (like a limited company). There is no separation between themselves and their business.
Let’s take a deeper look at what a Sole Trader is, how it works and some bonus bits that you may not know!
What is ‘Sole Trader’
As we mentioned a little further up, Sole Trader just refers to a business structure where an individual IS the business. I.e. if you woke up one day, went and bought some window cleaning gear and went door to door cleaning windows – you’d essentially be Sole Trader.
How do you become a Sole Trader?
It’s actually easier than you think to actually become a Sole Trader. To officially ‘be’ a Sole Trader, you have to register yourself for your self-assessment with HMRC.
‘What is a self-assessment’ I hear you cry – it just simply refers to your annual tax return. You just have to fill in a form with a few boxes that ask questions like ‘how much income did you earn’ and things like that – they then tell you how much you need to pay.
You also need to keep records of your business and finances for 5-6 years and you MUST register as for your self-assessment if your earnings exceed £1,000 (that’s non-negotiable).
Does it cost anything to set up as a Sole Trader?
I’ve actually written an article called ‘Going Self-Employed With No Money? I Got You Covered’ (spoiler alert – the cheapest option is Sole Trader) which runs through the basic setup processes as a Sole Trader, a couple of advantages/disadvantages, and ultimately, how much it costs. It’s a good read, however, if you don’t fancy it – the cost is zero pounds.
I do say it’s zero pounds, however this is assuming you opt for the most basic recording keeping and accounting options I mention in the article. The cost of setting yourself up can be much much higher if you start looking for top tier accounting systems and all-singing, all-dancing record keeping software.
How does a Sole Trader business structure work?
I can imagine this is quite a common question, hence the subheading but it doesn’t make a ton of sense, so bear with me whilst I try to navigate this…
There isn’t really a ‘structure’ so to speak…basically. There aren’t any fancy accounts you have to prepare and no complicated business-only tax returns you have to do – this is all private limited company territory.
You can literally just register for your self assessment then go out and start earning money – it’s really as simple as that.
Of course, you can have a trading name too (which ISN’T your name!) – my window cleaning service business card wouldn’t look great if it just had my full name on it. I’d want it to be something like ‘Alex’s Sparkly Windows’ or something like that.
There is absolutely no problem with having a separate name for the ‘business’ (I put that in quotes because you ARE the business but you know what I mean) – this is what we refer to as a ‘trading name’.
You need to make sure you’re consistent with your branding and that you include the trading name on all of the invoices you issue, etc.
What are the advantages/disadvantages of being a Sole Trader?
I mentioned a few on my ‘Going Self-Employed With No Money? I Got You Covered’ article but I’ll say them again plus maybe a few more.
Advantages of being Sole Trader
Filing requirements
Well… aside from your annual tax return – there aren’t any requirements. You may opt to have ‘Sole Trader accounts’ prepared by your accountant but it’s not a legal requirement – they just help to give you an overview of business performance and help you make strategic decisions.
Costs next to nothing to start
We covered this earlier but the cost of getting yourself up and running as Sole Trader is pretty much zero. As eight out of ten small businesses fail in the first 18 months of trading, you’ll want to get set up as cheaply as possible to avoid being one of those eight!
Super easy to change
By starting off as Sole Trader, you leave yourself and the business free to change to an organisational structure that best suits the business. For example, if you wanted to become a limited company – you can just get your company incorporated and start trading through there (although this isn’t as easy if we were to do this the other way round).
Disadvantages of being Sole Trader
No legal cover
Unfortunately, as there is no separation between a Sole Trader and their business – well, the issue is that you can separate a Sole Trader from his/her business… bear with me.
Say, in order to get your business’ feet off the ground, you take out a loan for the business with every intention of paying it back. However, money isn’t coming in quick enough to meet loan repayments and you default.
If you took this loan out through the limited company, the company would be legally liable (not you) and so your personal belongings are safe (as they’re not the property of the company).
Now, we take this same loan out but we’re a Sole Trader. We default on the loan – what is the bank going to do? COME FOR YOU. As you’re not legally separate from your business, they can actually seize your personal goods and even repossess your house!
Inefficient tax
If you operate through a limited company, you can essentially withdraw your money from the business as dividends and pay 7.5% on them (plus £2,000 Dividend Allowance!). However, with Sole Trader, you’re taxed as you are when you’re employed – you get the £12,500 personal allowance then taxed at 20%, 40%, etc.
It doesn’t take a genius to figure out that 7.5% tax is less than 20% tax.
Obviously, it’s not always as easy as that – you have to consider Corporation Tax that limited companies have to pay but that’s a story for another time.
Ultimately – becoming a Sole Trader is your easiest option if you just want to get straight into earning that cash money dollar… however just make sure you’re clued up on the potential downsides to this business structure and what you’re legally required to do in terms of tax, etc.